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Selective Insurance Group 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-11
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Filed by Bowne Pure Compliance
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2008
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 001-33067
SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
     
New Jersey   22-2168890
     
(State or Other Jurisdiction of Incorporation or Organization)   (I.R.S. Employer Identification No.)
     
40 Wantage Avenue    
Branchville, New Jersey   07890
     
(Address of Principal Executive Offices)   (Zip Code)
(973) 948-3000
(Registrant’s Telephone Number, Including Area Code)
 
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ      No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o      No þ
As of June 30, 2008, there were 52,679,813 shares of common stock, par value $2.00 per share, outstanding.
 
 

 

 


 

SELECTIVE INSURANCE GROUP, INC.
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 Exhibit 11
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

 


Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SELECTIVE INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
                 
    Unaudited        
    June 30,     December 31,  
($ in thousands, except share amounts)   2008     2007  
ASSETS
               
Investments:
               
Fixed maturity securities, held-to-maturity — at amortized cost
(fair value of: $4,071 — 2008; $5,927 — 2007)
  $ 3,979       5,783  
Fixed maturity securities, available-for-sale — at fair value
(amortized cost of: $3,081,830 — 2008; $3,049,913 — 2007)
    3,044,378       3,073,547  
Equity securities, available-for-sale — at fair value
(cost of: $143,084 — 2008; $160,390 — 2007)
    212,838       274,705  
Short-term investments — at cost which approximates fair value
    218,074       190,167  
Equity securities, trading — at fair value (cost of: $17,982 — 2008)
    23,196        
Other investments
    206,410       188,827  
 
           
Total investments
    3,708,875       3,733,029  
Cash and cash equivalents
    16,402       8,383  
Interest and dividends due or accrued
    34,992       36,141  
Premiums receivable, net of allowance for uncollectible accounts of: $4,157 — 2008; $3,905 — 2007
    524,680       496,363  
Other trade receivables, net of allowance for uncollectible accounts of: $226 — 2008; $244 — 2007
    23,602       21,875  
Reinsurance recoverable on paid losses and loss expenses
    5,729       7,429  
Reinsurance recoverable on unpaid losses and loss expenses
    248,011       227,801  
Prepaid reinsurance premiums
    88,978       82,182  
Current federal income tax
    1,140       4,235  
Deferred federal income tax
    68,193       22,375  
Property and equipment — at cost, net of accumulated depreciation and amortization of: $125,465 — 2008; $117,832 — 2007
    54,668       58,561  
Deferred policy acquisition costs
    225,645       226,434  
Goodwill
    33,637       33,637  
Other assets
    44,623       43,547  
 
           
Total assets
  $ 5,079,175       5,001,992  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities:
               
Reserve for losses
  $ 2,262,310       2,182,572  
Reserve for loss expenses
    375,451       359,975  
Unearned premiums
    868,851       841,348  
Senior convertible notes
          8,740  
Notes payable
    273,865       286,151  
Commissions payable
    44,987       60,178  
Accrued salaries and benefits
    84,166       88,079  
Other liabilities
    151,833       98,906  
 
           
Total liabilities
    4,061,463       3,925,949  
 
           
 
               
Stockholders’ Equity:
               
Preferred stock of $0 par value per share:
               
Authorized shares: 5,000,000; no shares issued or outstanding
               
Common stock of $2 par value per share:
               
Authorized shares: 360,000,000
               
Issued: 94,986,691 — 2008; 94,652,930 — 2007
    189,973       189,306  
Additional paid-in capital
    208,067       192,627  
Retained earnings
    1,147,287       1,105,946  
Accumulated other comprehensive income
    15,270       86,043  
Treasury stock — at cost (shares: 42,306,878 — 2008; 40,347,894 — 2007)
    (542,885 )     (497,879 )
 
           
Total stockholders’ equity
    1,017,712       1,076,043  
 
           
Commitments and contingencies
               
Total liabilities and stockholders’ equity
  $ 5,079,175       5,001,992  
 
           
The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

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Table of Contents

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
                                 
    Quarter ended     Six Months ended  
    June 30,     June 30,  
(in thousands, except per share amounts)   2008     2007     2008     2007  
Revenues:
                               
Net premiums written
  $ 387,229       404,923     $ 777,069       822,108  
Net increase in unearned premiums and prepaid reinsurance premiums
    (12,140 )     (28,572 )     (20,707 )     (65,744 )
 
                       
Net premiums earned
    375,089       376,351       756,362       756,364  
Net investment income earned
    38,515       40,642       76,381       80,505  
Net realized gains
    1,923       13,148       3,438       24,391  
Diversified Insurance Services revenue
    30,064       30,677       59,863       59,855  
Other income
    1,761       1,220       2,421       3,032  
 
                       
Total revenues
    447,352       462,038       898,465       924,147  
 
                       
 
                               
Expenses:
                               
Losses incurred
    209,915       208,621       420,045       411,931  
Loss expenses incurred
    43,736       42,615       86,785       85,598  
Policy acquisition costs
    124,124       124,701       252,804       247,619  
Dividends to policyholders
    1,579       1,022       2,114       2,509  
Interest expense
    5,127       5,992       10,436       12,323  
Diversified Insurance Services expenses
    25,125       24,608       50,639       49,419  
Other expenses
    1,661       6,693       12,955       17,763  
 
                       
Total expenses
    411,267       414,252       835,778       827,162  
 
                       
 
                               
Income before federal income tax
    36,085       47,786       62,687       96,985  
 
                       
 
                               
Federal income tax expense (benefit):
                               
Current
    12,883       14,726       24,018       30,337  
Deferred
    (5,449 )     (2,826 )     (10,485 )     (6,490 )
 
                       
Total federal income tax expense
    7,434       11,900       13,533       23,847  
 
                       
 
                               
Net income
  $ 28,651       35,886       49,154       73,138  
 
                       
 
                               
Earnings per share:
                               
Basic net income
  $ 0.55       0.69       0.94       1.38  
 
                       
 
                               
Diluted net income
  $ 0.54       0.64       0.92       1.26  
 
                       
 
                               
Dividends to stockholders
  $ 0.13       0.12       0.26       0.24  
The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                 
    Six Months Ended June 30,  
($ in thousands, except per share amounts)   2008     2007  
Common stock:
                               
Beginning of year
  $ 189,306               183,124          
Dividend reinvestment plan
(shares: 40,645 — 2008; 36,097 — 2007)
    81               72          
Convertible debentures
(shares: 45,759 — 2008; 848,604 — 2007)
    92               1,697          
Stock purchase and compensation plans
(shares: 247,357 — 2008; 702,919 — 2007)
    494               1,407          
 
                           
End of period
    189,973               186,300          
 
                           
 
                               
Additional paid-in capital:
                               
Beginning of year
    192,627               153,246          
Dividend reinvestment plan
    847               859          
Convertible debentures
    645               9,831          
Stock purchase and compensation plans
    13,948               16,857          
 
                           
End of period
    208,067               180,793          
 
                           
 
                               
Retained earnings:
                               
Beginning of year
    1,105,946               986,017          
Cumulative-effect adjustment due to adoption of FAS 159 net of deferred income tax effect of $3,344
    6,210                        
Net income
    49,154       49,154       73,138       73,138  
Cash dividends to stockholders
($0.26 share — 2008; $0.24 per share — 2007)
    (14,023 )             (13,216 )        
 
                           
End of period
    1,147,287               1,045,939          
 
                           
 
                               
Accumulated other comprehensive income:
                               
Beginning of year
    86,043               100,601          
Cumulative-effect adjustment due to adoption of FAS 159, net of deferred income tax effect of $(3,344)
    (6,210 )                      
Other comprehensive (loss) income, (decrease) increase in:
                               
Net unrealized gains on investment securities, net of deferred income tax effect of: $(34,803) — 2008; $(14,592) — 2007
    (64,633 )     (64,633 )     (27,099 )     (27,099 )
Defined benefit pension plans, net of deferred income tax effect of: $38 — 2008; $101 — 2007
    70       70       186       186  
 
                       
End of period
    15,270               73,688          
 
                           
Comprehensive (loss) income
            (15,409 )             46,225  
 
                           
 
                               
Treasury stock:
                               
Beginning of year
    (497,879 )             (345,761 )        
Acquisition of treasury stock
(shares: 1,958,984 — 2008; 5,386,005 — 2007)
    (45,006 )             (137,592 )        
 
                           
End of period
    (542,885 )             (483,353 )        
 
                           
Total stockholders’ equity
  $ 1,017,712               1,003,367          
 
                           
Selective Insurance Group, Inc. also has authorized, but not issued, 5,000,000 shares of preferred stock, without par value, of which 300,000 shares have been designated Series A junior preferred stock, without par value.
The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOW
                 
    Six Months ended  
    June 30,  
(in thousands)   2008     2007  
Operating Activities
               
Net income
  $ 49,154       73,138  
 
           
 
               
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    14,197       14,302  
Share-based compensation expense
    9,137       13,703  
Net realized gains
    (3,438 )     (24,391 )
Deferred tax
    (10,485 )     (6,490 )
Unrealized loss on trading securities
    1,631        
 
               
Changes in assets and liabilities:
               
Increase in reserves for losses and loss expenses, net of reinsurance recoverable on unpaid losses and loss expenses
    75,033       109,858  
Increase in unearned premiums, net of prepaid reinsurance and advance premiums
    20,350       66,234  
Decrease (increase) in net federal income tax recoverable
    3,095       (3,840 )
Increase in premiums receivable
    (28,317 )     (89,014 )
(Increase) decrease in other trade receivables
    (1,727 )     608  
Decrease (increase) in deferred policy acquisition costs
    789       (12,229 )
Decrease in interest and dividends due or accrued
    1,212       696  
Decrease in reinsurance recoverable on paid losses and loss expenses
    1,700       59  
Decrease in accrued salaries and benefits
    (4,301 )     (14,967 )
Decrease in accrued insurance expenses
    (20,756 )     (8,588 )
Purchase of trading securities
    (5,813 )      
Sale of trading securities
    6,100        
Other-net
    8,526       5,063  
 
           
Net adjustments
    66,933       51,004  
 
           
Net cash provided by operating activities
    116,087       124,142  
 
           
 
               
Investing Activities
               
Purchase of fixed maturity securities, available-for-sale
    (239,887 )     (231,392 )
Purchase of equity securities, available-for-sale
    (16,095 )     (54,214 )
Purchase of other investments
    (25,976 )     (33,580 )
Purchase of short-term investments
    (1,061,242 )     (861,197 )
Sale of fixed maturity securities, available-for-sale
    80,056       51,717  
Sale of short-term investments
    1,033,334       922,902  
Redemption and maturities of fixed maturity securities, held-to-maturity
    1,818       628  
Redemption and maturities of fixed maturity securities, available-for-sale
    158,685       176,295  
Sale of equity securities, available-for-sale
    34,585       60,321  
Proceeds from other investments
    3,798       8,558  
Purchase of property and equipment
    (3,851 )     (6,365 )
 
           
Net cash (used in) provided by investing activities
    (34,775 )     33,673  
 
           
 
               
Financing Activities
               
Dividends to stockholders
    (13,009 )     (12,023 )
Acquisition of treasury stock
    (45,006 )     (137,592 )
Principal payment of notes payable
    (12,300 )     (18,300 )
Net proceeds from stock purchase and compensation plans
    4,457       4,560  
Excess tax benefits from share-based payment arrangements
    1,319       2,656  
Principal payments of convertible bonds
    (8,754 )      
 
           
Net cash used in financing activities
    (73,293 )     (160,699 )
 
           
Net increase (decrease) in cash and cash equivalents
    8,019       (2,884 )
Cash and cash equivalents, beginning of year
    8,383       6,443  
 
           
Cash and cash equivalents, end of period
  $ 16,402       3,559  
 
           
 
               
Supplemental Disclosures of Cash Flows Information
               
Cash paid during the period for:
               
Interest
  $ 10,643       12,573  
Federal income tax
    19,600       32,000  
Supplemental schedule of non-cash financing activity:
               
Conversion of convertible debentures
    169       11,055  
The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. Organization
Selective Insurance Group, Inc., through its subsidiaries, (collectively referred to as “we” or “our”) offers property and casualty insurance products and diversified insurance services and products. Selective Insurance Group, Inc. was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. Selective Insurance Group, Inc.’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “SIGI.”
We classify our business into three operating segments:
    Insurance Operations, which sells property and casualty insurance products and services primarily in 22 states in the Eastern and Midwestern United States;
    Investments; and
    Diversified Insurance Services, which provides human resource administration outsourcing products and services, and federal flood insurance administrative services.
NOTE 2. Basis of Presentation
The interim unaudited consolidated financial statements (“Financial Statements”) contained in this report include the accounts of our parent company and its subsidiaries, and have been prepared in conformity with: (i) U.S. generally accepted accounting principles (“GAAP”); and (ii) the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. The preparation of Financial Statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported financial statement balances, as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. All significant intercompany accounts and transactions between our parent company and its subsidiaries are eliminated in consolidation.
The Financial Statements reflect all adjustments that, in our opinion, are normal, recurring, and necessary for a fair presentation of our results of operations and financial condition. The Financial Statements cover the second quarters ended June 30, 2008 (“Second Quarter 2008”) and June 30, 2007 (“Second Quarter 2007”) and the six-month periods ended June 30, 2008 (“Six Months 2008”) and June 30, 2007 (“Six Months 2007”). The Financial Statements do not include all of the information and disclosures required by GAAP and the SEC for audited financial statements. Results of operations for any interim period are not necessarily indicative of results for a full year. Consequently, the Financial Statements should be read in conjunction with the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2007 (“2007 Annual Report”).
NOTE 3. Adoption of Accounting Pronouncements
In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities (“FSP 03-6-1”). FSP 03-6-1 addresses the treatment of unvested share-based payment awards containing nonforfeitable rights to dividends or dividend equivalents in the calculation of earnings per share and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. We are currently evaluating the impact of FSP 03-6-1 on our calculation of earnings per share.
In May 2008, the FASB issued FSP No. APB 14-1, Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement) (“FSP 14-1”). FSP 14-1 applies to convertible debt instruments that, by their stated terms, may be completely or partially settled in cash (or other assets) upon conversion, unless the embedded conversion option is required to be separately accounted for as a derivative under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. FSP 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We are currently evaluating the applicability of FSP 14-1 to our operations.

 

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In May 2008, the FASB issued Statement of Financial Accounting Standards No. 163, Accounting for Financial Guarantee Insurance Contracts — an interpretation of FASB Statement No. 60 (“FAS 163”). FAS 163 applies to financial guarantee insurance and reinsurance contracts that are: (i) issued by enterprises that are included within the scope of FASB Statement of Financial Accounting Standards No. 60, Accounting and Reporting by Insurance Enterprises (“FAS 60”); and (ii) not accounted for as derivative instruments. FAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of FAS 163 is not expected to have an impact on our results of operations or financial condition.
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (“FAS 162”). FAS 162 identifies the sources of generally accepted accounting principles and provides a framework, or hierarchy, for selecting the principles to be used in preparing financial statements for non-governmental entities in conformity with GAAP. This statement will be effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly In Conformity with Generally Accepted Accounting Principles. The adoption of FAS 162 is not expected to have an impact on our results of operations or financial condition.
In June 2007, the Emerging Issues Task Force (“EITF”) of FASB issued EITF Issue No. 06-11 Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (“EITF 06-11”). EITF 06-11 requires that the tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options be recognized as an increase to additional paid-in capital. EITF 06-11, was effective on a prospective basis beginning with dividends declared in fiscal years beginning after December 15, 2007, and we adopted it in the first quarter of 2008. The adoption of EITF 06-11 did not have a material impact on our results of operations or financial condition.
NOTE 4. Investments
Fair Value Measurements
On January 1, 2008, we adopted FASB Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (“FAS 159”). FAS 159 provides companies with an option to report selected financial assets and liabilities at fair value (“fair value option”). We elected to apply the fair value option to a portfolio of securities currently being managed by one outside manager, as this manager requires the flexibility to trade as necessary in order to maximize returns and we do not have the ability to hold these securities throughout any anticipated recovery periods. The securities for which we elected the fair value option were previously held as available-for-sale securities and are now classified as trading securities.
The following table provides information regarding the reclassification and corresponding cumulative-effect adjustment on retained earnings resulting from the initial application of FAS 159 for this portfolio:
                         
    Pre-Adoption             Post-Adoption  
    Carrying/Fair     Impact of     Carrying/Fair  
    Value     Fair Value     Value  
    at     Election     at  
($ in thousands)   January 1, 2008     Adoption     January 1, 2008  
Equity securities:
                       
Available-for-sale securities
  $ 274,705       (25,113 )     249,592  
Trading securities
          25,113       25,113  
 
                 
Total equity securities
    274,705             274,705  
 
                 
                         
            Accumulated        
            Other        
    Retained     Comprehensive        
($ in thousands)   Earnings     Income     Total  
 
                       
Beginning balance at January 1, 2008
  $ 1,105,946       86,043       1,191,989  
Pre-tax cumulative effect of adoption of fair value option
    9,554       (9,554 )      
Deferred tax impact
    (3,344 )     3,344        
 
                 
Adjusted beginning balance at January 1, 2008
    1,112,156       79,833       1,191,989  
 
                 

 

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On January 1, 2008, we also adopted FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“FAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. The impact of adoption of FAS 157 did not have a material impact on our results of operations or financial condition.
The following table provides quantitative disclosures regarding fair value measurements of our invested assets:
                                 
            Fair Value Measurements at 6/30/08 Using  
            Quoted Prices in     Significant        
    Assets     Active Markets     Other     Significant  
    Measured at     for Identical     Observable     Unobservable  
Description   Fair Value at     Assets     Inputs     Inputs  
($ in thousands)   6/30/08     (Level 1)     (Level 2)     (Level 3)  
Trading securities:
                               
Equity securities
  $ 23,196       23,196              
Available-for-sale securities:
                               
Fixed maturity securities
    3,044,378       43,403       3,000,975        
Equity securities
    212,838       212,838              
Short-term investments
    218,074       218,074              
Other investments1
    28,866             28,866        
 
                       
Total
  $ 3,527,352       497,511       3,029,841        
 
                       
     
1   Alternative investments, included in “Other investments” in the Consolidated Balance Sheets, are not included in the above table, as they are accounted for under the equity method of accounting and are not carried at fair value.
Investment income associated with the above invested assets is included in net investment income in the Consolidated Income Statement, including unrealized gains and losses on our trading securities. In Second Quarter and Six Months 2008, net investment income included $0.3 million gain and $1.6 million loss of fair value measurements, respectively, representing the change in market value on our trading securities.
Fair market valuations in the above table were generated using various valuation techniques. Level 1 fair market values were derived through the use of quoted prices in an active market for identical assets. Level 2 fair market values were derived through matrix pricing, which is a mathematical technique used principally to value debt securities by relying on the securities’ relationship to other benchmark quoted securities, and not by relying exclusively on quoted prices for specific securities. We had no Level 3 fair market values as of June 30, 2008.
Net realized gains
During Second Quarter 2008, our net realized gains on available-for-sale fixed maturity securities included $9.8 million of other-than-temporary impairment charges associated with seven asset-backed securities (“ABSs”), one residential mortgage-backed security (“RMBS”), and one corporate bond. The majority of these other-than-temporary impairment charges were associated with issuer-specific credit events that revolved around the performance of the underlying collateral, which had deteriorated in Second Quarter 2008. In general, these securities were experiencing increased conditional default rates and loss severities and, as a result, our stress test scenarios were indicating less of a margin to absorb losses going forward. Although the majority of these securities were insured or guaranteed by mono-line bond guarantors, recent downgrades of these guarantors have reduced our confidence in their ability to perform in the event of default. In addition, credit support for these securities has also begun to erode, thereby further increasing the potential for eventual loss. The lack of an underlying rating and collateral performance that had deteriorated over the past three months presented negative credit and pricing pressure; therefore, we could no longer reasonably assert that the recovery period, if any, would be temporary. As a result of our evaluation, we recorded other-than-temporary impairment charges of $9.8 million, which resulted in a corresponding decrease in net realized gains from fixed maturities in Second Quarter and Six Months 2008.

 

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NOTE 5. Reinsurance
The following table contains a listing of direct, assumed, and ceded reinsurance amounts by income statement caption. For more information concerning reinsurance, refer to Note 7, “Reinsurance” in Item 8. “Financial Statements and Supplementary Data” in our 2007 Annual Report.
                                 
    Unaudited,     Unaudited,  
    Quarter ended     Six Months ended  
    June 30,     June 30,  
($ in thousands)   2008     2007     2008     2007  
Premiums written:
                               
Direct
  $ 441,189       451,894       876,565       908,373  
Assumed
    2,577       3,322       7,247       7,806  
Ceded
    (56,537 )     (50,293 )     (106,743 )     (94,071 )
 
                       
Net
  $ 387,229       404,923       777,069       822,108  
 
                       
 
                               
Premiums earned:
                               
Direct
  $ 417,988       413,588       841,163       828,352  
Assumed
    7,422       7,810       15,146       16,180  
Ceded
    (50,321 )     (45,047 )     (99,947 )     (88,168 )
 
                       
Net
  $ 375,089       376,351       756,362       756,364  
 
                       
 
                               
Losses and loss expenses incurred:
                               
Direct
  $ 301,939       302,006       560,893       553,750  
Assumed
    5,295       5,694       10,312       12,365  
Ceded
    (53,583 )     (56,464 )     (64,375 )     (68,586 )
 
                       
Net
  $ 253,651       251,236       506,830       497,529  
 
                       
Excluding flood losses, ceded losses and loss expenses incurred decreased $6.0 million in Second Quarter 2008 and $9.9 million in Six Months 2008 compared to the same periods in 2007 due to normal volatility in losses that are ceded to our reinsurers under our casualty and property excess of loss treaties.
The ceded premiums and losses related to our Flood operations are as follows:
                                 
    Unaudited,     Unaudited,  
    Quarter ended     Six Months ended  
National Flood Insurance Program   June 30,     June 30,  
($ in thousands)   2008     2007     2008     2007  
Ceded premiums written
  $ (43,585 )     (38,082 )   $ (81,363 )     (70,101 )
Ceded premiums earned
    (37,558 )     (32,155 )     (74,065 )     (63,036 )
Ceded losses and loss expenses incurred
    (45,429 )     (42,311 )     (50,217 )     (44,574 )
NOTE 6. Segment Information
We have classified our operations into three segments, the disaggregated results of which are reported to, and used by, senior management to manage our operations:
    Insurance Operations, which are evaluated based on statutory underwriting results (net premiums earned (“NPE”), incurred losses and loss expenses, policyholders dividends, policy acquisition costs, and other underwriting expenses), and statutory combined ratios;
    Investments, which are evaluated based on net investment income and net realized gains and losses; and
    Diversified Insurance Services, which, because they are not dependent on insurance underwriting cycles, are evaluated based on several measures including, but not limited to, results of operations in accordance with GAAP, with a focus on return on revenues (net income divided by revenues).

 

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We do not aggregate any of our operating segments. The Insurance Operations and Diversified Insurance Services segments share a common marketing or distribution system and create new opportunities for independent insurance agents to bring value-added services and products to our customers. Our commercial and personal lines property and casualty insurance products, flood insurance, and human resource administration outsourcing products are sold through independent insurance agents.
Our subsidiaries also provide services to each other in the normal course of business. These transactions totaled $3.5 million in Second Quarter 2008 and $6.9 million in Six Months 2008 compared with $4.5 million in Second Quarter 2007 and $8.9 million in Six Months 2007. These transactions were eliminated in all consolidated statements. In computing the results of each segment, we do not make adjustments for interest expense, net general corporate expenses, or federal income taxes. We do not maintain separate investment portfolios for the segments and therefore, do not allocate assets to the segments.
The following tables present revenues (net investment income and net realized gains on investments in the case of the Investments segment) and pre-tax income for the individual segments:
                                 
    Unaudited,     Unaudited,  
    Quarter ended     Six Months ended  
Revenue by segment   June 30,     June 30,  
($ in thousands)   2008     2007     2008     2007  
Insurance Operations:
                               
Net premiums earned:
                               
Commercial automobile
  $ 77,758       78,814       156,982       157,603  
Workers compensation
    77,502       80,873       155,968       163,349  
General liability
    99,932       101,602       203,201       205,062  
Commercial property
    48,575       46,796       98,511       93,364  
Business owners’ policy
    14,383       13,034       28,525       25,875  
Bonds
    4,718       4,676       9,493       9,376  
Other
    164       171       329       348  
 
                       
Total commercial lines
    323,032       325,966       653,009       654,977  
 
                       
Personal automobile
    32,942       33,107       65,547       67,043  
Homeowners
    16,975       15,373       33,546       30,515  
Other
    2,140       1,905       4,260       3,829  
 
                       
Total personal lines
    52,057       50,385       103,353       101,387  
 
                       
Total net premiums earned
    375,089       376,351       756,362       756,364  
 
                       
Miscellaneous income
    1,761       1,220       2,421       2,971  
 
                       
Total Insurance Operations revenues
    376,850       377,571       758,783       759,335  
Investments:
                               
Net investment income
    38,515       40,642       76,381       80,505  
Net realized gain on investments
    1,923       13,148       3,438       24,391  
 
                       
Total investment revenues
    40,438       53,790       79,819       104,896  
Diversified Insurance Services:
                               
Human resource administration outsourcing
    13,498       14,928       28,616       31,723  
Flood insurance
    14,013       13,656       26,110       24,066  
Other
    2,553       2,093       5,137       4,066  
 
                       
Total Diversified Insurance Services revenues
    30,064       30,677       59,863       59,855  
 
                       
Total all segments
    447,352       462,038       898,465       924,086  
 
                       
Other income
                      61  
 
                       
Total revenues
  $ 447,352       462,038       898,465       924,147  
 
                       

 

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    Unaudited,     Unaudited,  
    Quarter ended     Six Months ended  
Income before federal income tax   June 30,     June 30,  
($ in thousands)   2008     2007     2008     2007  
Insurance Operations:
                               
Commercial lines underwriting
  $ (85 )     6,957       4,286       19,587  
Personal lines underwriting
    (3,166 )     (7,102 )     (8,989 )     (10,015 )
 
                       
Underwriting (loss) income, before federal income tax
    (3,251 )     (145 )     (4,703 )     9,572  
 
                       
GAAP combined ratio
    100.9 %     100.0 %     100.6 %     98.7  
 
                       
Statutory combined ratio
    98.7 %     97.1 %     98.5 %     96.4  
 
                       
Investments:
                               
Net investment income
    38,515       40,642       76,381       80,505  
Net realized gain on investments
    1,923       13,148       3,438       24,391  
 
                       
Total investment income, before federal income tax
    40,438       53,790       79,819       104,896  
 
                       
Diversified Insurance Services:
                               
Income before federal income tax
    4,939       6,069       9,224       10,436  
 
                       
Total all segments
    42,126       59,714       84,340       124,904  
 
                       
Interest expense
    (5,127 )     (5,992 )     (10,436 )     (12,323 )
General corporate expenses
    (914 )     (5,936 )     (11,217 )     (15,596 )
 
                       
 
                               
Income before federal income tax
  $ 36,085       47,786       62,687       96,985  
 
                       
NOTE 7. Retirement Plans
The following tables show the costs of the Retirement Income Plan for Selective Insurance Company of America (“Retirement Income Plan”) and the retirement life insurance component (“Retirement Life Plan”) of the Selective Insurance Company of America Welfare Benefits Plan. For more information concerning these plans, refer to Note 16, “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data” in our 2007 Annual Report.
                                 
    Retirement Income Plan     Postretirement Plan  
    Unaudited,     Unaudited,  
    Quarter ended June 30,     Quarter ended June 30,  
($ in thousands)   2008     2007     2008     2007  
Components of Net Periodic Benefit Cost:
                               
Service cost
  $ 1,758       1,788       80       81  
Interest cost
    2,441       2,184       135       125  
Expected return on plan assets
    (2,960 )     (2,710 )            
Amortization of unrecognized prior service cost
    38       37       (8 )     (8 )
Amortization of unrecognized net loss
    24       115              
Special termination benefit
          900             100  
 
                       
Net periodic cost
  $ 1,301       2,314       207       298  
 
                       
                                 
    Retirement Income Plan     Postretirement Plan  
    Unaudited,     Unaudited,  
    Six Months ended June 30,     Six Months ended June 30,  
($ in thousands)   2008     2007     2008     2007  
Components of Net Periodic Benefit Cost:
                               
Service cost
  $ 3,517       3,576       161       162  
Interest cost
    4,881       4,368       269       250  
Expected return on plan assets
    (5,921 )     (5,420 )            
Amortization of unrecognized prior service cost
    75       75       (16 )     (16 )
Amortization of unrecognized net loss
    49       229              
Special termination benefit
          900             100  
 
                       
Net periodic cost
  $ 2,601       3,728       414       496  
 
                       

 

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NOTE 8. Comprehensive (Loss)/Income
The components of comprehensive (loss)/income, both gross and net of tax, for Second Quarter 2008 and Second Quarter 2007 are as follows:
                         
Second Quarter 2008                  
(in thousands)   Gross     Tax     Net  
Net income
  $ 36,085       7,434       28,651  
 
                 
Components of other comprehensive loss:
                       
Unrealized losses on securities:
                       
Unrealized holding losses during the period
    (56,493 )     (19,773 )     (36,720 )
Less: Reclassification adjustment for gains included in net income
    (1,923 )     (673 )     (1,250 )
 
                 
Net unrealized losses
    (58,416 )     (20,446 )     (37,970 )
Defined benefit pension plans:
                       
Reversal of amortization items:
                       
Net actuarial loss
    24       8       16  
Prior service cost
    30       11       19  
 
                 
Defined benefit pension plans
    54       19       35  
 
                 
Comprehensive loss
  $ (22,277 )     (12,993 )     (9,284 )
 
                 
                         
Second Quarter 2007                  
(in thousands)   Gross     Tax     Net  
Net income
  $ 47,786       11,900       35,886  
 
                 
Components of other comprehensive income:
                       
Unrealized losses on securities:
                       
Unrealized holding losses during the period
    (23,571 )     (8,250 )     (15,321 )
Less: Reclassification adjustment for gains included in net income
    (13,148 )     (4,602 )     (8,546 )
 
                 
Net unrealized losses
    (36,719 )     (12,852 )     (23,867 )
Defined benefit pension plans:
                       
Reversal of amortization items:
                       
Net actuarial loss
    113       40       73  
Prior service cost
    30       10       20  
 
                 
Defined benefit pension plans
    143       50       93  
 
                 
Comprehensive income
  $ 11,210       (902 )     12,112  
 
                 
The components of comprehensive (loss)/income, both gross and net of tax, for Six Months 2008 and Six Months 2007 are as follows:
                         
Six Months 2008                  
(in thousands)   Gross     Tax     Net  
Net income
  $ 62,687       13,533       49,154  
 
                 
Components of other comprehensive loss:
                       
Unrealized losses on securities:
                       
Unrealized holding losses during the period
    (96,008 )     (33,603 )     (62,405 )
Less: Reclassification adjustment for gains included in net income
    (3,428 )     (1,200 )     (2,228 )
 
                 
Net unrealized losses
    (99,436 )     (34,803 )     (64,633 )
Defined benefit pension plans:
                       
Reversal of amortization items:
                       
Net actuarial loss
    49       17       32  
Prior service cost
    59       21       38  
 
                 
Defined benefit pension plans
    108       38       70  
 
                 
Comprehensive loss
  $ (36,641 )     (21,232 )     (15,409 )
 
                 

 

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Six Months 2007                  
(in thousands)   Gross     Tax     Net  
Net income
  $ 96,985       23,847       73,138  
 
                 
Components of other comprehensive income:
                       
Unrealized losses on securities:
                       
Unrealized holding losses during the period
    (17,300 )     (6,055 )     (11,245 )
Less: Reclassification adjustment for gains included in net income
    (24,391 )     (8,537 )     (15,854 )
 
                 
Net unrealized losses
    (41,691 )     (14,592 )     (27,099 )
Defined benefit pension plans:
                       
Reversal of amortization items:
                       
Net actuarial loss
    227       80       147  
Prior service cost
    60       21       39  
 
                 
Defined benefit pension plans
    287       101       186  
 
                 
Comprehensive income
  $ 55,581       9,356       46,225  
 
                 
NOTE 9. Commitments and Contingencies
At June 30, 2008, we had contractual obligations to invest up to an additional $144 million in other investments that expire at various dates through 2023. There is no certainty that any such additional investment will be required.
NOTE 10. Litigation
In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our seven insurance subsidiaries (the “Insurance Subsidiaries”) as either: (i) liability insurers defending or providing indemnity for third-party claims brought against insureds; or (ii) insurers defending first-party coverage claims brought against them. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Our management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.
Our Insurance Subsidiaries are also from time to time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Our Insurance Subsidiaries are also from time to time involved in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
In this Quarterly Report on Form 10-Q, we discuss and make statements regarding our intentions, beliefs, current expectations, and projections regarding our company’s future operations and performance. Such statements are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as “anticipates,” “believes,” “expects,” “will,” “should,” and “intends” and their negatives. We caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in our future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. “Risk Factors” in our 2007 Annual Report. These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors may emerge from time to time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. We make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.
Introduction
We offer property and casualty insurance products and diversified insurance services through our various subsidiaries. We classify our businesses into three operating segments: (i) Insurance Operations; (ii) Investments; and (iii) Diversified Insurance Services.
The purpose of the Management’s Discussion and Analysis (“MD&A”) is to provide an understanding of the consolidated results of operations and financial condition and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our 2007 Annual Report.
In the MD&A, we will discuss and analyze the following:
  Critical Accounting Policies and Estimates;
  Financial Highlights of Results for Second Quarter 2008 and Six Months 2008;
  Results of Operations and Related Information by Segment;
  Financial Condition, Liquidity, and Capital Resources;
  Off-Balance Sheet Arrangements;
  Contractual Obligations and Contingent Liabilities and Commitments; and
  Federal Income Taxes.
Critical Accounting Policies and Estimates
These unaudited interim consolidated financial statements include amounts based on our informed estimates and judgments for those transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the financial statements. Those estimates and judgments that were most critical to the preparation of the consolidated financial statements involved the following: (i) reserves for losses and loss expenses; (ii) deferred policy acquisition costs; (iii) pension and postretirement benefit plan actuarial assumptions; (iv) other-than-temporary investment impairments; (v) goodwill; and (vi) reinsurance. These estimates and judgments require the use of assumptions about matters that are highly uncertain and, therefore, are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements. Our 2007 Annual Report, pages 37 through 44, provides a discussion of each of these critical accounting policies.

 

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Financial Highlights of Results for Second Quarter 2008 and Six Months 2008
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
Financial Highlights   June 30,     % or     June 30,     % or  
($ in thousands, except per share amounts)   2008     2007     Points     2008     2007     Points  
 
                                               
Revenues
  $ 447,352       462,038       (3 )%   $ 898,465       924,147       (3 )%
Net income
    28,651       35,886       (20 )     49,154       73,138       (33 )
Diluted net income per share
    0.54       0.64       (16 )     0.92       1.26       (27 )
Diluted weighted-average outstanding shares
    53,064       56,721       (6 )     53,461       58,610       (9 )
GAAP combined ratio
    100.9 %     100.0     0.9 pts     100.6 %     98.7     1.9 pts
Statutory combined ratio
    98.7 %     97.1       1.6       98.5 %     96.4       2.1  
Annualized return on average equity
    11.1 %     14.1     (3.0 )pts     9.4 %     14.1     (4.7 )pts
Net income decreased in Second Quarter and Six Months 2008 compared to the same periods last year due to:
    Pre-tax net investment gains decreased $11.2 million, to $1.9 million, in Second Quarter 2008 and by $21.0 million, to $3.4 million, in Six Months 2008. These decreases reflect other-than-temporary impairment charges of $9.8 million in Second Quarter 2008 due to significant market changes and collateral deterioration across the credit markets. Additionally, higher gains were recognized in the first quarter of 2007 as a result of the sale of various equity securities to reallocate sector exposures. For additional information regarding these other-than-temporary impairment charges, refer to the section below entitled, “Investments.”
    A decrease in pre-tax underwriting results from our Insurance Operations segment of $3.1 million, to an underwriting loss of $3.3 million, in Second Quarter 2008, and $14.3 million, to an underwriting loss of $4.7 million, in Six Months 2008. These deteriorations were primarily driven by increased catastrophe losses related to 2008 storm activity in portions of our southern and mid-western regions coupled with reduced favorable prior year loss development. These items were partially offset by improvements in our workers compensation line of business from the execution of our strategic initiatives.
    A decrease in pre-tax net investment income of $2.1 million, to $38.5 million, in Second Quarter 2008 and $4.1 million, to $76.4 million, in Six Months 2008 primarily due to lower returns on our other investments portfolio, partially offset by higher fixed maturity income as a result of a higher invested asset base. In addition, Six Months 2008 includes a $1.6 million loss reflecting the reduction in the fair value of our equity trading portfolio.
Partially offsetting the net income decreases above was a decrease in general corporate expenses related to employee long-term stock compensation awards in both Second Quarter and Six Months 2008 compared to the same periods last year reflecting, among other items, the decrease in the market value of our common stock within the comparable periods.
Diluted net income per share decreased in Second Quarter and Six Months 2008 compared to Second Quarter and Six Months 2007 due to the net income decreases described above, partially offset by the reduction in diluted weighted-average shares outstanding from actions taken under our capital management program. As part of our capital management program, in the twelve-month period ending June 30, 2008, we repurchased approximately 2.3 million shares under our authorized repurchase programs and, during the fourth quarter of 2007, we net-share settled our senior convertible notes resulting in the issuance of approximately 1.2 million shares as well as the elimination of approximately 3.2 million common stock equivalents.

 

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Results of Operations and Related Information by Segment
Insurance Operations
Our Insurance Operations segment writes property and casualty insurance business through our Insurance Subsidiaries. Effective June 30, 2008, two of our Insurance Subsidiaries, Selective Insurance Company of the Southeast and Selective Insurance Company of South Carolina, changed their regulatory state of domicile from North Carolina and South Carolina, respectively, to Indiana. This change will help us achieve certain operational efficiencies that will generate ongoing savings of approximately $2 million annually. Our Insurance Operations segment sells property and casualty insurance products and services primarily in 22 states in the Eastern and Midwestern United States through approximately 920 independent insurance agencies. Our Insurance Operations segment consists of two components: (i) commercial lines (“Commercial Lines”), which markets primarily to businesses, and represents approximately 86% of net premiums written (“NPW”), and (ii) personal lines (“Personal Lines”), which markets primarily to individuals, and represents approximately 14% of NPW. The underwriting performance of these lines are generally measured by four different statutory ratios: (i) loss and loss expense ratio; (ii) underwriting expense ratio; (iii) dividend ratio; and (iv) combined ratio. For further details regarding these ratios see the discussion in the “Insurance Operations Results” section of Item 1. “Business.” of our 2007 Annual Report.
Summary of Insurance Operations
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
All Lines   June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
GAAP Insurance Operations Results:
                                               
NPW
  $ 387,229       404,923       (4 )%     777,069       822,108       (5 )%
 
                                       
NPE
    375,089       376,351             756,362       756,364        
Less:
                                               
Losses and loss expenses incurred
    253,651       251,236       1       506,830       497,529       2  
Net underwriting expenses incurred
    123,110       124,238       (1 )     252,121       246,754       2  
Dividends to policyholders
    1,579       1,022       55       2,114       2,509       (16 )
 
                                       
Underwriting (loss) income
  $ (3,251 )     (145 )     n/m %     (4,703 )     9,572       (149 )%
 
                                       
GAAP Ratios:
                                               
Loss and loss expense ratio
    67.6 %     66.8     0.8 pts     67.0 %     65.8     1.2 pts
Underwriting expense ratio
    32.9 %     32.9             33.3 %     32.6       0.7  
Dividends to policyholders ratio
    0.4 %     0.3       0.1       0.3 %     0.3        
 
                                       
Combined ratio
    100.9 %     100.0       0.9       100.6 %     98.7       1.9  
 
                                       
Statutory Ratios:1
                                               
Loss and loss expense ratio
    66.9 %     66.0       0.9       66.4 %     65.2       1.2  
Underwriting expense ratio
    31.4 %     30.8       0.6       31.8 %     30.9       0.9  
Dividends to policyholders ratio
    0.4 %     0.3       0.1       0.3 %     0.3        
 
                                       
Combined ratio
    98.7 %     97.1     1.6 pts     98.5 %     96.4     2.1 pts
 
                                       
     
1   The statutory ratios include the flood line of business, which is included in the Diversified Insurance Services Segment on a GAAP basis and therefore excluded from the GAAP ratios. The total Statutory Combined Ratio excluding flood is 99.5% for Second Quarter 2008 and 99.2% for Six Months 2008 compared to 98.1% for Second Quarter 2007 and 97.1% for Six Months 2007.
    NPW decreased in Second Quarter and Six Months 2008 compared to Second Quarter and Six Months 2007 due to the highly competitive insurance marketplace and the slowing economy. These factors are evidenced as follows:
    Reductions in new business of $17.6 million, to $74.3 million, in Second Quarter 2008, and $28.0 million, to $149.0 million, in Six Months 2008 compared to the same periods last year.
    Reductions in endorsement and audit activity of $9.8 million, to a net return of premium of $3.6 million, in Second Quarter 2008 and $16.3 million, to a net return of premium of $5.2 million, in Six Months 2008 compared to the same periods last year. Previously, these transactions typically resulted in additional premium due to the growth of the insured businesses over the course of the policy period.

 

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These decreases were partially offset by:
    Increased net renewals of $13.2 million, to $331.1 million, in Second Quarter 2008 and $7.6 million, to $660.8 million, in Six Months 2008 compared to the same periods last year. These renewals include relatively flat Commercial Lines retention of 78% in Second Quarter and Six Months 2008 and Second Quarter and Six Months 2007, and renewal price decreases, including exposure, of 1% in Second Quarter 2008 and 0.7% in Six Months 2008 compared to decreases, of 0.5% in Second Quarter 2007 and 0.1% in Six Months 2007. In response to the highly competitive marketplace, our agents are actively managing our books of business by renewing accounts as much as 60 days in advance of the policy expiration date.
    Increased Personal Lines NPW due to higher rates on both homeowners and personal automobile premiums. For additional information regarding Personal Lines rate filings, see the section below entitled, “Personal Lines Results.”
    As the decreases in NPW have not yet been fully recognized into income, NPE is flat in Second Quarter and Six Months 2008 compared to the same periods last year.
    The GAAP loss and loss expense ratio increased 0.8 points in Second Quarter 2008 compared to Second Quarter 2007 reflecting: (i) a 1.7-point increase due to higher catastrophe losses related to storm activity in portions of our southern and mid-western regions; and (ii) a 0.8-point increase related to less favorable prior year loss development than the previous year. These items were partially offset by improvements in our workers compensation line of business from the execution of our strategic initiatives, coupled with a decrease in non-catastrophe property losses due to normal volatility of losses in the commercial property line of business.
 
      The 1.2-point increase in the GAAP loss and loss expense ratio in Six Months 2008 compared to Six Months 2007 includes: (i) a 0.8-point increase related to higher catastrophe losses; (ii) a 0.6-point increase related to less favorable prior year loss development primarily in our commercial automobile line of business; and (iii) increased losses from the first quarter of 2008 on the physical damage portion of our commercial automobile line of business that added 0.6 points to the loss and loss expense ratio. Partially offsetting these items are improvements in the workers compensation line of business.
 
      In our continual efforts to manage our claims process and reduce our loss and loss expense ratio, we have instituted a number of initiatives that are focused on best practices in the following areas:
    Claims automation;
    Claims quality and control;
    Litigation management;
    Compliance and bill review; and
    Salvage and subrogation.
We anticipate that these initiatives will reduce cycle time and improve workflows, resulting in the quicker establishment of case reserves, thus leading to lower ultimate loss costs through reduced legal and loss adjustment expenses. In the near term, the quicker establishment of loss reserves inflates our severity statistics, but the longer-term benefit is a refined management of the claims process.
    The increase in the GAAP underwriting expense ratio in Six Months 2008 compared to Six Months 2007 was primarily attributable to a pre-tax restructuring charge of $3.6 million, or 0.5 points, in the first quarter of 2008 related to our workforce reduction initiative.
 
      We continue to manage our expenses through the following cost containment initiatives: (i) closely monitoring labor costs as reflected in our reduced headcount year-over-year and the above-mentioned restructuring; (ii) targeted changes to our agency commission program implemented in July 2008 and expected to generate a $7 million pre-tax savings; and (iii) the re-domestication of two of our insurance subsidiaries effective June 30, 2008, achieve operational efficiencies with an anticipated annual pre-tax savings of $2 million annually. However, improvements in the underwriting expense ratio resulting from the above initiatives could potentially be offset by reduced premium levels.

 

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Insurance Operations Outlook
Historically, the results of the property and casualty insurance industry have experienced significant fluctuations due to competition, economic conditions, interest rates, loss cost trends, and other factors. Since 2006, the commercial lines sector of the industry has experienced a softening market. This softening market was evident in the first quarter of 2008, when premiums within the U.S. property/casualty insurance industry declined by 2.2% according to “U.S. Property/Casualty — 1st Quarter Financial Review” from A.M. Best, dated June 30, 2008. The premium decline is attributed to pricing pressure and broader policy terms, coupled with weaker economic conditions driven by soaring energy prices, the sluggish housing market, the credit crunch, and a weaker job market. Standard & Poor’s (“S&P”) indicated its belief that, if price declines continue at their current pace, analyst outlooks on some commercial lines carriers will likely be revised downward in the second half of 2008, possibly leading to a negative outlook for the commercial lines sector by the end of the year. Within our commercial lines of business, the pricing trends observed in the first quarter have continued to intensify during the second quarter. We believe that these trends will continue within the commercial lines sector throughout the remainder of 2008.
S&P maintained a stable outlook regarding the U.S. personal lines marketplace in their mid-year update, noting an anticipated increase in merger and acquisition activity, while stating concerns over the long-term sustainability of earnings considering competitive market conditions, a softer pricing cycle, reserve development that is expected to shift towards strengthening, and loss cost inflation that is expected to outpace premium growth. In our Personal Lines business, the growth in NPW and the reduction in combined ratios in 2008 reflect greater pricing accuracy from our new automated MATRIX® system, targeted rate increases across our Personal Lines footprint, and lower expenses due to the Personal Lines restructuring in Second Quarter 2007.
In an effort to grow our business profitably in the current commercial and personal lines market conditions, we have implemented a clearly defined plan to improve risk selection and mitigate higher frequency and severity trends to complement our strong agency relationships and unique field-based model. Some of the tools we use to lower frequency and severity are our business analytics initiatives, including knowledge management and predictive modeling, safety management, managed care, and enhanced claims review.
We have also developed market-planning tools that allow us to strategically appoint additional independent agencies and agency management specialists (“AMSs”) in under-penetrated territories that have classes of business we know historically have been profitable. During Six Months 2008, the Insurance Subsidiaries added more than 60 independent insurance agencies, bringing our total agency count to approximately 920 as of June 30, 2008. These independent insurance agencies are serviced by approximately 100 field-based AMSs who make hands-on underwriting decisions on a daily basis.
In addition to this “high touch” component of our business model, we have developed technology that allows agents and the Insurance Subsidiaries’ field teams to input business seamlessly into our systems, while also allowing them to select and price accounts at optimal levels through our business analytics tools. Technology that allows for the seamless placement of business into our systems includes our One & Done® small business system and our xSELerate® straight-through processing system. Premiums of $275,271 per workday were processed through our One & Done® small business system in Second Quarter 2008, up 10% from Second Quarter 2007. We have set a multi-year small business growth target of $350,000 in One & Done® business per work day, and in 2008 our efforts are centered on: (i) better managing price points and scale; (ii) implementing a more comprehensive marketing and branding strategy; and (iii) updating the distribution model to address agent and customer needs. Although overall commercial lines new business was down 21%, our One & Done® new business was up 16% for the Six Months 2008 compared to Six Months 2007.
We also continue to pursue our organic growth strategy. In June 2008, we entered our 22nd primary state, Tennessee, where we completed our initial appointment of 10 agencies and started writing Commercial Lines business. We expect to start writing Personal Lines business in late 2008. In addition to our organic growth strategy, we are taking note of opportunities that marketplace competition may be creating and do not rule out making an opportunistic acquisition.

 

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Review of Underwriting Results by Line of Business
Commercial Lines Results
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
Commercial Lines   June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
GAAP Insurance Operations Results:
                                               
NPW
  $ 331,038       351,469       (6 )%     671,124       721,725       (7 )%
 
                                       
NPE
    323,032       325,966       (1 )     653,009       654,977        
Less:
                                               
Losses and loss expenses incurred
    216,133       212,065       2       429,322       420,323       2  
Net underwriting expenses incurred
    105,405       105,922             217,287       212,558       2  
Dividends to policyholders
    1,579       1,022       55       2,114       2,509       (16 )
 
                                       
Underwriting (loss) income
  $ (85 )     6,957       (101 )%     4,286       19,587       (78 )%
 
                                       
GAAP Ratios:
                                               
Loss and loss expense ratio
    66.9 %     65.1     1.8 pts     65.7 %     64.2     1.5 pts
Underwriting expense ratio
    32.6 %     32.5       0.1       33.3 %     32.5       0.8  
Dividends to policyholders ratio
    0.5 %     0.3       0.2       0.3 %     0.4       (0.1 )
 
                                       
Combined ratio
    100.0 %     97.9       2.1       99.3 %     97.1       2.2  
 
                                       
Statutory Ratios:
                                               
Loss and loss expense ratio
    66.5 %     64.6       1.9       65.3 %     63.8       1.5  
Underwriting expense ratio
    31.8 %     31.0       0.8       32.2 %     30.7       1.5  
Dividends to policyholders ratio
    0.5 %     0.3       0.2       0.3 %     0.4       (0.1 )
 
                                       
Combined ratio
    98.8 %     95.9     2.9 pts     97.8 %     94.9     2.9 pts
 
                                       
    NPW decreased in Second Quarter and Six Months 2008 compared to the same periods last year due to the highly competitive insurance marketplace and the slowing economy. These factors are evidenced in total Commercial Lines new business, which decreased $20.1 million, to $62.6 million, in Second Quarter 2008 and $33.1 million, to $126.2 million, in Six Months 2008. In addition, endorsement and audit activity decreased by $9.8 million, to a net premium return of $4.1 million in Second Quarter 2008 and $16.2 million, to a net premium return of $5.9 million, in Six Months 2008.
 
      Partially offsetting these NPW decreases is net renewal activity that increased by $13.1 million, to $285.7 million, in Second Quarter 2008 and $7.3 million, to $575.3 million, in Six Months 2008 compared to the same periods last year. These renewals include relatively flat retention of 78% in Second Quarter and Six Months 2008 and Second Quarter and Six Months 2007 and commercial lines renewal price decreases, including exposure, of 1.0% in Second Quarter 2008 and 0.7% in Six Months 2008 compared to decreases of 0.5% in Second Quarter 2007 and 0.1% in Six Months 2007. In response to the highly competitive marketplace, our agents are actively managing our books of business by renewing accounts as much as 60 days in advance of the policy expiration date.
    The GAAP loss and loss expense ratio increased 1.8 points in Second Quarter 2008 compared to Second Quarter 2007 reflecting: (i) a 1.9-point increase in catastrophe losses related to storm activity in portions of our southern and mid-western regions; and (ii) a 1.2-point increase related to less favorable prior year loss development. These items were partially offset by improvements in our workers compensation line of business from the execution of our strategic initiatives, coupled with a decrease in non-catastrophe property loss due to normal volatility of losses in the commercial property line of business.
 
      The increase in the GAAP loss and loss expense ratio in Six Months 2008 compared to Six Months 2007 includes: (i) a 0.9-point increase related to higher catastrophe losses; (ii) a 0.6-point increase related to decreased favorable prior year loss development; and (iii) a 0.7-point increase due to normal volatility in the physical damage portion of our commercial automobile line of business. Partially offsetting these items are improvements in our workers compensation line of business.
    The higher GAAP underwriting expense ratio in Six Months 2008 compared to Six Months 2007 was primarily driven by a $3.6 million restructuring charge in the first quarter of 2008, of which $3.1 million was related to our Commercial Lines business. The restructuring charge, which added approximately 0.5 points to the Commercial Lines GAAP underwriting ratio, reflects costs associated with our workforce reduction expense initiative in the first quarter of 2008.

 

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The following is a discussion on our most significant commercial lines of business:
General Liability
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
    June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
 
                                               
Statutory NPW
  $ 105,042       110,348       (5 )%     216,325       229,039       (6 )%
Statutory NPE
    99,932       101,602       (2 )     203,201       205,062       (1 )
Statutory combined ratio
    103.3 %     100.1     3.2 pts     100.2 %     97.5     2.7 pts
% of total statutory commercial NPW
    32 %     31               32 %     32          
NPW for this line of business decreased in Second Quarter and Six Months 2008 compared to the same periods last year, primarily driven by decreases in new business premiums of $6.5 million, to $17.9 million, in Second Quarter 2008 and $9.4 million, to $36.8 million, in Six Months 2008. Despite significant competition in our middle market and large account business, overall policy counts for this line increased 5% in Second Quarter and Six Months 2008 from the same periods in 2007. Retention on this line remained stable at approximately 76% in Second Quarter and Six Months 2008 and Second Quarter and Six Months 2007, reflecting moderate growth in our small account business, which we define as policies with premiums less than $25,000.
Pricing pressure and higher loss costs continue to challenge profitability in this line of business. However, we continue to concentrate on maintaining our underwriting discipline, which focuses on: (i) contractor growth in business segments with lower completed operations exposures; and (ii) contract and subcontractor underwriting guidelines to minimize losses.
Workers Compensation
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
    June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
 
                                               
Statutory NPW
  $ 78,753       90,259       (13 )%     159,053       183,910       (14 )%
Statutory NPE
    77,501       80,884       (4 )     155,968       163,372       (5 )
Statutory combined ratio
    98.6 %     102.2     (3.6 )pts     96.5 %     100.2     (3.7 )pts
% of total statutory commercial NPW
    24 %     26               24 %     25          
In Second Quarter and Six Months 2008, NPW on this line decreased, primarily as the result of: (i) competitive pressure from mono-line workers compensation writers, mainly on the upper end of our middle market business and our large account business; (ii) a one-point decrease in retention to 78%; and (iii) lower renewal prices, including exposure, which decreased 0.1% in Second Quarter 2008, compared to an increase of 2.5% in Second Quarter 2007, and increased 0.4% in Six Months 2008 compared to an increase of 2.6% in Six Months 2007. Policy counts increased by 4% in both Second Quarter and Six Months 2008. Due to the fact that we are writing more, smaller premium policies and the average policy premium for this line decreased approximately 12% in Second Quarter 2008 and 13% in Six Months 2008. NPE decreases in Second Quarter and Six Months 2008 compared to the same periods last year are attributable to NPW decreases during the last twelve months.

 

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The improvement in the statutory combined ratio of 3.6 points in Second Quarter 2008 and 3.7 points in Six Months 2008 compared to the same periods last year reflects: (i) favorable prior year statutory development of approximately $3 million, or 3.9 points, in Second Quarter 2008 and $7 million, or 4.5 points in Six Months 2008 compared to no significant prior year statutory development in Second Quarter 2007 and approximately $2 million, or 1.2 points, in Six Months 2007; and (ii) the ongoing progress resulting from the execution of our multi-faceted workers compensation strategy, which incorporates our business analytics tools and underwriting process improvements that enable us to retain and write more of our agents’ best accounts.
Commercial Automobile
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
    June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
 
                                               
Statutory NPW
  $ 78,483       82,781       (5 )%     158,682       170,528       (7 )%
Statutory NPE
    77,758       78,814       (1 )     156,982       157,603        
Statutory combined ratio
    96.2 %     84.1     12.1 pts     98.2 %     86.1     12.1 pts
% of total statutory commercial NPW
    24 %     23               23 %     24          
NPW for this line of business decreased in Second Quarter and Six Months 2008 compared to the same periods last year due primarily due to lower new business premiums in this line of business, which were $12.4 million in Second Quarter 2008, down $4.4 million or 26%, and $24.6 million in Six Months 2008, down $6.9 million or 22%. Retention on this line of business was down one point to 80% in both Second Quarter and Six Months 2008. As with the general liability line, we are experiencing the highest level of competition in our middle market and large account business, while our small account business, which we define as policies with premiums less than $25,000, experienced moderate growth. Overall policy counts for this line increased 4% in Second Quarter and Six Months 2008 compared to the same periods in 2007.
The increase in the statutory combined ratio for this line is primarily due to:
    No significant prior year development in Second Quarter or Six Months 2008 compared to favorable prior year development of approximately $7 million, or 8.9 points, in Second Quarter 2007 and approximately $10 million, or 6.3 points in Six Months 2007 due to lower than anticipated severity in accident years 2004 through 2006.
    Physical damage losses that were $0.7 million, or 1 point, higher in Second Quarter 2008 and $4.5 million, or 2.9 points, higher in Six Months 2008 compared to the same periods last year. These increases reflect normal volatility that is inherent in property line results.
    Renewal price decreases on this line, which is our most competitive line of business, including exposure, of 3.1% in Second Quarter 2008 and 3.2% in Six Months 2008 compared to 3.0% in Second Quarter 2007 and 2.6% in Six Months 2007.
Commercial Property
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
    June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
 
                                               
Statutory NPW
  $ 48,986       49,431       (1 )%     97,230       100,498       (3 )%
Statutory NPE
    48,575       46,796       4       98,511       93,364       6  
Statutory combined ratio
    94.4 %     94.0     0.4 pts     95.5 %     93.1     2.4 pts
% of total statutory commercial NPW
    15 %     14               14 %     14          
NPW for this line of business decreased in Second Quarter and Six Months 2008 compared to Second Quarter and Six Months 2007 due to new business premium decreases of $0.8 million, to $11.6 million, in Second Quarter 2008 and $2.3 million, to $22.6 million, in Six Months 2008 coupled with a one point decrease in retention to 77% in Second Quarter and Six Months 2008. NPE increases in Second Quarter and Six Months 2008 compared to the same periods last year are attributable to NPW increases during the last twelve months.

 

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The statutory combined ratio increases in both Second Quarter and Six Months 2008 compared to the same periods last year are attributable to catastrophe losses of $9.0 million in Second Quarter 2008 and $12.3 million in Six Months 2008 related to storm activity in our southern and mid-western regions compared to catastrophe losses of $4.4 million in Second Quarter 2007 and $7.9 million in Six Months 2007. Second Quarter 2008 catastrophe losses were partially offset by decreases in non-catastrophe property losses, reflecting the normal volatility inherent in this line of business.
Personal Lines Results
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
Personal Lines   June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
GAAP Insurance Operations Results:
                                               
NPW
  $ 56,191       53,454       5 %     105,945       100,383       6 %
 
                                       
NPE
    52,057       50,385       3       103,353       101,387       2  
Less:
                                               
Losses and loss expenses incurred
    37,518       39,171       (4 )     77,508       77,206        
Net underwriting expenses incurred
    17,705       18,316       (3 )     34,834       34,196       2  
 
                                       
Underwriting loss
  $ (3,166 )     (7,102 )     55 %     (8,989 )     (10,015 )     10 %
 
                                       
GAAP Ratios:
                                               
Loss and loss expense ratio
    72.1 %     77.7     (5.6 )pts     75.0 %     76.1     (1.1 )pts
Underwriting expense ratio
    34.0 %     36.4       (2.4 )     33.7 %     33.7        
 
                                   
Combined ratio
    106.1 %     114.1       (8.0 )     108.7 %     109.8       (1.1 )
 
                                       
Statutory Ratios:1
                                               
Loss and loss expense ratio
    70.4 %     75.1       (4.7 )     74.0 %     74.7       (0.7 )
Underwriting expense ratio
    27.7 %     30.4       (2.7 )     28.8 %     31.0       (2.2 )
 
                                   
Combined ratio
    98.1 %     105.5     (7.4 )pts     102.8 %     105.7     (2.9 )pts
 
                                       
     
1   The statutory ratios include the flood line of business, which is included in the Diversified Insurance Services Segment on a GAAP basis and therefore excluded from the GAAP ratios. The total Personal Lines statutory combined ratio excluding flood is 103.5% for Second Quarter 2008 and 107.6% for Six Months 2008 compared to 112.7% for Second Quarter 2007 and 111.4% for Six Months 2007.
    NPW increased in Second Quarter and Six Months 2008 compared to Second Quarter and Six Months 2007 primarily due to:
    Rate actions on our personal automobile line of business, including average renewal rates of 7-13% in various states, including a 6.8% increase in New Jersey that was effective in May 2008.
    Rate actions on our homeowners line of business, including average renewal rate increases of 4.5% in New Jersey that was effective in April 2007, as well as increases in various other states of 5-7%.
    Policy count increases of 3% in Second Quarter 2008 and 4% in Six Months 2008 compared the same periods last year.
    Increased retention in our homeowners line of business of one point to 87% in Six Months 2008 compared to Six Months 2007.
As of June 30, 2008, New Jersey personal automobile business represented 38% of total Personal Lines premium compared to 42% as of June 30, 2007.
    The decrease in the GAAP loss and loss expense ratio in Second Quarter and Six Months 2008 compared to the same periods in the prior year was driven by premium increases in the respective periods coupled with the following for the Second Quarter 2008: (i) no significant prior year development in Second Quarter 2008 compared to unfavorable prior year development of approximately $1 million in Second Quarter 2007, which increased the GAAP loss and loss expense ratio in Second Quarter 2007 by 2.1 points; and (ii) a decrease in property losses of $0.7 million, or 2.1 points, in Second Quarter 2008 compared to Second Quarter 2007.

 

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    The GAAP underwriting expense ratio improved in Second Quarter 2008 compared to Second Quarter 2007 primarily due to costs associated with the reorganization of the Personal Lines Department in May of 2007 that reduced the staffing level by 31 employees. This reorganization added 2.6 points to the underwriting expense ratio in Second Quarter 2007.
 
      The GAAP underwriting expense ratio remained flat in Six Months 2008 compared to Six Months 2007. The impact of costs associated with the 2007 reorganization of the Personal Lines Department, which added 1.3 points to the underwriting ratio in Six Months 2007, was partially offset by the impact of the restructuring charge in the first quarter of 2008 related to our workforce reduction initiative. This 2008 restructuring charge, which amounted to approximately $0.5 million for Personal Lines, added approximately 0.5 points to the Personal Lines GAAP underwriting ratio in Six Months 2008.
In order to further address profitability concerns in our Personal Lines, we have developed an improvement plan that incorporates the following:
    Two automobile rate increases of approximately 6.5% each in New Jersey, effective in May and October 2008. These rate increases apply to all automobile business written in New Jersey. In addition to the New Jersey increases, we have filed or implemented other rate increases in various other states for our automobile business that range between 5-17%. Some of these increases apply to all automobile business in such states and some only apply to automobile business written prior to the implementation of MATRIX®.
    In August 2008, we will be able to receive the full indicated rate on all MATRIX® automobile renewal business in New Jersey, as these policies will no longer be subject to the 20% annual cap imposed by the New Jersey Department of Banking and Insurance.
    Homeowners rate increases of 5.0% in New Jersey were filed in Second Quarter 2008. Additionally, we have filed or implemented other rate actions include implemented or filed increases in various other states for our homeowners business that range between 6-14%.
Reinsurance
We have successfully completed negotiations of our July 1, 2008 excess of loss treaties with highlights as follows:
Property Excess of Loss
The Property Excess of Loss treaty was renewed with a $28.0 million limit in excess of a $2.0 million retention, a $5 million increase from the prior treaty of $23.0 million limit in a excess of a $2.0 million retention.
    The per occurrence cap on the second layer was increased to $40.0 million from $22.5 million, bringing the total per occurrence limit for the program to $64.0 million compared to the $46.5 million limit in the expiring treaty.
    The annual aggregate limit for the second $20.0 million in excess of $10.0 million layer was also increased, by an additional reinstatement, to $80.0 million. The first layer continues to have unlimited reinstatements.
Casualty Excess of Loss
The Casualty Excess of Loss treaty (“Casualty Treaty”) was restructured effective July 1, 2008 into one treaty encompassing all casualty lines, including workers compensation. As a result, the Workers Compensation Only treaty was not renewed at July 1, 2008. The current program provides the following coverage:
    The first layer was expanded from a workers compensation only layer to now include all lines, which significantly reduces uncertainty surrounding losses in that layer. This layer provides coverage up to 65% of $3.0 million in excess of a $2.0 million retention.
    The next four layers provide coverage up to 100% of $45.0 million in excess of a $5.0 million retention.
    The sixth layer provides coverage up to 75% of $40.0 million in excess of a $50.0 million retention.
    Consistent with the prior year, the Casualty Treaty excludes nuclear, biological, chemical, and radiological terrorism losses. Annual aggregate terrorism limits, net of co-participation including a $40.0 million in excess of $50.0 million layer, is $175.8 million for all losses.
The cost of layers above $5 million has decreased 2% to $10 million. On a fiscal year basis, the ceded premium for the entire casualty program will be approximately $10 million above the expiring premium due to the significant extension in coverage. The overall impact of the restructured program will be to improve insurance operations by about $2.0 million with lower investment income being offset due to higher ceded premium.

 

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Investments
Our investment portfolio consists primarily of fixed maturity investments (82%), but also contains equity securities (6%), short-term investments (6%), and other investments (6%). Our investment philosophy includes certain return and risk objectives for the fixed maturity and equity portfolios. The primary fixed maturity portfolio return objective is to maximize after-tax investment yield and income while balancing risk; a secondary objective is to meet or exceed a weighted-average benchmark of public fixed income indices. The equity portfolio return objective is to meet or exceed a weighted-average benchmark of public equity indices. We aim to structure our portfolio conservatively with a focus on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of the Insurance Operations segment; (iv) consideration of taxes; and (v) preservation of capital.
                                                 
    Unaudited             Unaudited        
    Quarter ended     Change     Six Months ended     Change  
    June 30,     % or     June 30,     % or  
($ in thousands)   2008     2007     Points     2008     2007     Points  
 
                                               
Net investment income — before tax
  $ 38,515       40,642       (5 )%     76,381       80,505       (5 )%
Net investment income — after tax
    30,082       31,788       (5 )     59,453       62,945       (6 )
Total invested assets
                            3,708,875       3,541,366       5  
Effective tax rate
    21.9 %     21.8       0.1 pts     22.2 %     21.8       0.4 pts
Annual after-tax yield on fixed maturity securities
                            3.6 %     3.6        
Annual after-tax yield on investment portfolio
                            3.2 %     3.5       (0.3 )
The decreases in net investment income, before tax, of $2.1 million for Second Quarter 2008 and $4.1 million in Six Months 2008 compared to Second Quarter and Six Months 2007 were primarily attributable to decreased returns on the alternative investment portion of our other investments portfolio of $3.8 million, to $0.3 million, in Second Quarter 2008 and $4.3 million, to $2.2 million, in Six Months 2008 due, in part, to the slowing of merger and acquisition activity in the current credit tightening environment. Partially offsetting the reduced alternative investment return is increased income on our fixed maturity security portfolio due to a higher invested asset base. In addition, Six Months 2008 includes a $1.6 million reduction in the fair value of our equity trading portfolio.
We continue to maintain a conservative, diversified investment portfolio, with fixed maturity investments representing 82% of invested assets. The portfolio has an average S&P rating of “AA+.” The following table presents the Moody’s Investor Service (“Moody’s”) and S&P’s ratings of our fixed maturities portfolio:
                 
    Unaudited        
    June 30,     December 31,  
Rating   2008     2007  
Aaa/AAA
    51 %     69 %
Aa/AA
    33 %     16 %
A/A
    11 %     9 %
Baa/BBB
    5 %     6 %
Ba/BB or below
    <1 %     <1 %
 
           
Total
    100 %     100 %
 
           
The shift in the percentage of securities rated “AAA” to those rated “AA” since December 31, 2007 is primarily due to downgrades of mono-line insurers, which have adversely impacted the ratings on our municipal bond and ABS portfolios. At June 30, 2008, municipal securities with insurance enhancement represented 27% of our fixed maturity securities portfolio and the average credit rating of the underlying securities was “AA-.” High credit quality continues to be a cornerstone of our investment strategy, as almost 100% of the fixed maturity securities in our portfolio are investment grade. At June 30, 2008, non-investment grade securities (below “BBB-”) represented less than 1%, or approximately $8 million, of our fixed maturity portfolio. Our mortgage-backed securities portfolio totaled $679.2 million at June 30, 2008, with an average credit rating of “AA+.” Within our investment portfolio, we define sub prime exposure as exposure to direct and indirect investments in non-agency residential mortgages with average FICO® scores below 650. Our bond portfolio, as of June 30, 2008, included one security with a cost and market value of $1.5 million that has a FICO® score below 650. Our RMBS, residential asset-backed securities (“RABS”) and commercial mortgage-backed securities (“CMBS”) portfolios also include $68.9 million of Alternative A securities (“Alt-A”) rated AAA by S&P and $5.4 million in Alt-A collateralized debt obligations (“CDOs”) rated A-.

 

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To manage and mitigate exposure, we perform analysis on mortgage-backed securities both at the time of purchase and as part of the ongoing portfolio evaluation. This analysis includes review of average FICO® scores, loan-to-value ratios, geographic spread of the assets securing the bond, delinquencies in payments for the underlying mortgages, gains/losses on sales as well as other information that aids in determination of the health of the underlying assets. We also consider overall credit environment, economic conditions, total projected return on the investment, and overall asset allocation of the portfolio in our decisions to purchase or sell structured securities.
Our fixed maturity investment strategy is to make security purchases that are attractively priced in relation to perceived credit risks. We manage the interest rate risk associated with holding fixed maturity investments by monitoring and maintaining the average duration of the portfolio to achieve an adequate after-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. We invest the fixed maturities portfolio primarily in intermediate-term securities to limit the overall interest rate risk of fixed maturity investments. Generally, the Insurance Subsidiaries have a duration mismatch between assets and liabilities. The duration of the fixed maturity portfolio, including short-term investments, is 3.8 years compared to a liability duration of approximately 3.4 years for the Insurance Subsidiaries. The current duration of the fixed maturities is within our historical range and is monitored and managed to maximize yield and limit interest rate risk. The duration mismatch is managed with a laddered maturity structure and an appropriate level of short-term investments that avoids liquidation of available-for-sale fixed maturities in the ordinary course of business. Liquidity is always a consideration when buying or selling securities but, because of the high quality and active market for the majority of securities in our investment portfolio, the securities sold have not diminished the overall liquidity of our portfolio. Our normal liquidity requirements have historically been met by operating cash flow from the Insurance Operations and Diversified Insurance Services segments. We expect future liquidity requirements to be met by these sources of funds or, if necessary, from borrowings under our credit facility or the issuance of debt and equity securities. Managing investment risk by adhering to these strategies is intended to protect the interests of the policyholders of our Insurance Subsidiaries and our stockholders, while enhancing our financial strength and underwriting capacity.
Realized Gains and Losses
Realized gains and losses are determined on the basis of the cost of specific investments sold and are credited or charged to income. Also included in realized gains and losses are write-downs for other-than-temporary impairment charges. The following table summarizes our net realized gains by investment type:
                                 
    Unaudited     Unaudited     Unaudited     Unaudited  
    Quarter ended     Quarter ended     Six Months ended     Six Months ended  
($ in thousands)   June 30, 2008     June 30, 2007     June 30, 2008     June 30, 2007  
Held-to-maturity fixed maturities
                               
Gains
  $             10        
Losses
                       
Available-for-sale fixed maturities
                               
Gains
    525       139       1,058       355  
Losses
    (13,144 )     (703 )     (14,298 )     (1,008 )
Available-for-sale equity securities
                               
Gains
    15,100       13,774       17,697       25,464  
Losses
    (558 )     (62 )     (1,029 )     (420 )
 
                       
Total net realized gains
  $ 1,923       13,148       3,438       24,391  
 
                       
Our realized gains from equity securities in Second Quarter and Six Months 2008 were primarily due to the sale of certain long-term equity investments in an effort to reallocate various portfolio and sector exposures.
Our realized losses from fixed maturities in Second Quarter and Six Months 2008 include other-than-temporary impairment charges. The determination that a security has incurred an other-than-temporary decline in value requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term prospects and all the relevant facts and circumstances. For additional information on our periodic evaluation for other-than-temporary impairment, refer to “Critical Accounting Policies and Estimates” contained in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our 2007 Annual Report.

 

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During Second Quarter 2008, our realized losses on available-for-sale fixed maturity securities included $9.8 million of other-than-temporary impairment charges associated with seven ABSs, one RMBS, and one corporate bond. We also had $2.8 million in realized losses in connection with the sale of two ABSs. The majority of these other-than-temporary impairment charges, as well as the two securities that were sold, were associated with issuer-specific credit events that revolved around the performance of the underlying collateral, which had materially deteriorated during Second Quarter 2008. In general, these securities were experiencing increased conditional default rates and loss severities, and as a result, our stress test scenarios were indicating less of a margin to absorb losses going forward. Although the majority of these securities were insured or guaranteed by mono-line bond guarantors, recent downgrades have reduced our confidence in their ability to perform in the event of default. In addition, credit support for these securities has also begun to erode, thereby further increasing the potential for eventual loss. The lack of an underlying rating and collateral performance that had deteriorated over the past three months presented negative credit and pricing pressure; therefore, we could no longer reasonably assert that the recovery period, if any, would be temporary. As a result of our evaluation, we recorded other-than-temporary impairment charges of $9.8 million, which resulted in the corresponding increase in realized losses from fixed maturities in Second Quarter and Six Months 2008.
Despite the issues surrounding the securities above, we maintain a high quality and liquid investment portfolio and the sale of securities that produced realized gains or impairment charges that produced realized losses did not change the overall liquidity of the investment portfolio. Our general philosophy for sales of securities is to reduce our exposure to securities and sectors based upon economic evaluations and when the fundamentals for that security or sector have deteriorated. We typically have a long investment time horizon and the turnover is low, which has resulted in many securities accumulating large unrealized gains. Every purchase or sale is made with the intent of improving future investment returns.
The following tables present the period of time that available-for-sale fixed maturity and equity securities sold at a loss were continuously in an unrealized loss position prior to sale:
                                 
    Unaudited     Unaudited  
    Quarter ended     Quarter ended  
    June 30, 2008     June 30, 2007  
Period of time in an   Fair             Fair        
unrealized loss position   Value on     Realized     Value on     Realized  
($ in millions)   Sale Date     Loss     Sale Date     Loss  
Fixed maturities:
                               
0 – 6 months
  $ 16.7       0.3       13.8       0.2  
7 – 12 months
    3.8       0.2       5.3       0.1  
Greater than 12 months
    2.2       2.8       10.2       0.2  
 
                       
Total fixed maturities
    22.7       3.3       29.3       0.5  
 
                       
Equity securities:
                               
0 – 6 months
    0.1       0.1       1.4       0.1  
7 – 12 months
    3.1       0.4              
Greater than 12 months
                       
 
                       
Total equity securities
    3.2       0.5       1.4       0.1  
 
                       
Total
  $ 25.9       3.8       30.7       0.6  
 
                       
                                 
    Unaudited     Unaudited  
    Six Months ended     Six Months ended  
    June 30, 2008     June 30, 2007  
Period of time in an   Fair             Fair        
unrealized loss position   Value on     Realized     Value on     Realized  
($ in millions)   Sale Date     Loss     Sale Date     Loss  
Fixed maturities:
                               
0 – 6 months
  $ 16.7       0.3       13.8       0.2  
7 – 12 months
    8.6       0.4       5.3       0.1  
Greater than 12 months
    2.2       2.8       10.2       0.2  
 
                       
Total fixed maturities
    27.5       3.5       29.3       0.5  
 
                       
Equity securities:
                               
0 – 6 months
    3.6       0.5       2.6       0.3  
7 – 12 months
    3.2       0.5       0.3       0.2  
 
                       
Total equity securities
    6.8       1.0       2.9       0.5  
 
                       
Total
  $ 34.3       4.5       32.2       1.0  
 
                       

 

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Unrealized Losses
The following table summarizes the aggregate fair value and gross pre-tax unrealized losses recorded in our accumulated other comprehensive income by asset class and by length of time for all available-for-sale securities that have continuously been in an unrealized loss position at June 30, 2008 and December 31, 2007:
                                 
    Unaudited        
    June 30, 2008     December 31, 2007  
Period of time in an           Gross             Gross  
unrealized loss position   Fair     Unrealized     Fair     Unrealized  
($ in millions)   Value     Loss     Value     Loss  
Fixed maturities:
                               
0 – 6 months
  $ 921.4       18.4       219.2       8.0  
7 – 12 months
    157.1       23.8       188.6       11.6  
Greater than 12 months
    232.0       26.5       340.5       5.7  
 
                       
Total fixed maturities
    1,310.5       68.7       748.3       25.3  
 
                       
Equities:
                               
0 – 6 months
    25.0       1.6       25.7       1.1  
7 – 12 months
    16.9       2.9       1.1       0.4  
 
                       
Total equity securities
    41.9       4.5       26.8       1.5  
 
                       
Total
  $ 1,352.4       73.2       775.1       26.8  
 
                       
Unrealized losses for fixed maturity securities and equities increased, primarily due to the credit stress which caused credit spreads to widen, dislocation in the capital markets, inflation worries, and general uncertainty about the U.S. economy. As of June 30, 2008, there were 413 securities in our portfolio in an unrealized loss position, including certain securities that were priced at a significant discount to cost due to the uncertainties in the marketplace. However, broad changes in the overall market or interest rate environment generally do not lead to impairment charges and, therefore, based on our analyses, which includes our review of the credit worthiness of the issuers, coupled with our ability and intent to hold the securities throughout their anticipated recovery periods, none of these securities are considered other-than-temporarily impaired.
However, in spite of our continued belief that unrealized losses on certain securities are not necessarily predictive of the ultimate performance of the underlying collateral, future write-downs may be necessary in light of unprecedented market and liquidity disruptions.
We have no available-for-sale fixed maturity securities, with fair values continuously less than 85% of their amortized costs for more than nine months as of June 30, 2008. The following tables present information regarding the severity of unrealized losses and, for those securities with a fair value of less than 85% of their amortized cost, information regarding the duration of the unrealized loss position as of June 30, 2008:
                 
Fair Value as a percentage of Amortized Cost   Unrealized     Fair  
($ in millions)   (Loss) Gain     Value  
85% but less than 100% of amortized cost
  $ (32.3 )     1,222.1  
75% but less than 85% of amortized cost
    (7.7 )     34.3  
Less than 75% of amortized cost
    (28.7 )     54.1  
 
           
Gross unrealized losses on fixed maturity securities
    (68.7 )     1,310.5  
Gross unrealized gains on fixed maturity securities
    31.2       1,733.9  
 
           
Net unrealized losses on fixed maturity securities
  $ (37.5 )     3,044.4  
 
           
                 
    75% but less     Less than  
    than 85% of     75% of  
Duration of Unrealized Loss Position   Amortized     Amortized  
($ in millions)   Cost     Cost  
0 – 3 months
  $ (2.5 )     (3.6 )
4 – 6 months
    (5.2 )     (11.9 )
7 – 9 months
          (13.2 )
 
           
Gross unrealized losses
  $ (7.7 )     (28.7 )
 
           

 

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In addition, the following table presents information regarding our available-for-sale fixed maturities that were in an unrealized loss position at June 30, 2008 by contractual maturity:
                 
Contractual Maturities   Amortized     Fair  
($ in millions)   Cost     Value  
One year or less
  $ 75.0       72.2  
Due after one year through five years
    507.9       485.1  
Due after five years through ten years
    665.6       634.4  
Due after ten years through fifteen years
    114.4       105.3  
Due after fifteen years
    16.3       13.5  
 
           
Total
  $ 1,379.2       1,310.5  
 
           
Investments Outlook
The escalating credit crisis and interest rate volatility continued into Second Quarter 2008 as more economic indicators point to an extended period of economic slowdown or recession. The Federal Funds rate was reduced by 25 basis points, to 2%, in April 2008 and future rate actions are uncertain in light of inflationary concerns. The difficult economy may lead to increased corporate loan default rates and there is the possibility of a global recession, as economic growth in Japan and Europe is expected to soften.
For fixed maturity securities, yield and income generation remain the key drivers to our investment strategy and our overall philosophy is to invest with a long-term horizon and a “buy-and-hold” principle. Reliance on independent investment research to avoid potential difficulties will continue to be a key driver behind our investment decisions. The continued volatility in fixed income spreads may provide attractive investment opportunities, particularly in the municipal bond sector.
With all these risks present, we are increasingly cautious in the equities markets and will continue to manage through this period of uncertainty by investing in companies with more defensive characteristics, such as strong balance sheets and reasonable valuations. Other considerations are favorable long-term corporate performance and attractive relative historical valuations.
Our long-term outlook for our other investments portfolio continues to be positive, particularly relative to other traditional asset classes of stocks, bonds, and cash. Investors with available cash are finding assets for sale at very attractive terms in these difficult markets. However, in the near term, we expect the current credit crisis to curb merger and acquisition activity, which will reduce the returns that many private equity sponsors have been able to realize over the past few years. The expected slowdown in merger and acquisition activity and the corresponding reduction in distributions to private equity investors have begun to materialize. Long-term, we believe these conditions create a favorable investment environment, as risk has been repriced and financial discipline will be restored to the financial markets.

 

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Diversified Insurance Services Segment
The Diversified Insurance Services operations consist of two core functions: (i) human resource administration outsourcing (“HR Outsourcing”); and (ii) flood insurance. These operations contributed $0.06 per diluted share in Second Quarter 2008 compared to $0.07 per diluted share in Second Quarter 2007, and $0.11 per diluted share in Six Months 2008 compared to $0.12 per diluted share in Six Months 2007. We evaluate the performance of these operations based on several measures, including, but not limited to, results of operations in accordance with GAAP, with a focus on our return on revenue (net income divided by revenues). The results for this segment’s continuing operations are as follows:
                                                 
    Unaudited             Unaudited        
    Quarter ended             Six Months ended        
    June 30,     % Change     June 30,     % Change  
($ in thousands)   2008     2007     or Points     2008     2007     or Points  
HR Outsourcing
                                               
Revenue
  $ 13,498       14,928       (10 )%   $ 28,616       31,723       (10 )%
Pre-tax profit
    841       1,341       (37 )     1,577       2,599       (39 )
Flood Insurance
                                               
Revenue
    14,013       13,656       3       26,110       24,066       8  
Pre-tax profit
    2,983       3,765       (21 )     5,042       5,767       (13 )
Other
                                               
Revenue
    2,553       2,093       22       5,137       4,066       26  
Pre-tax profit
    1,115       963       16       2,605       2,070       26  
Total
                                               
Revenue
    30,064       30,677       (2 )     59,863       59,855        
Pre-tax profit
    4,939       6,069       (19 )     9,224       10,436       (12 )
After-tax profit
    3,270       4,019       (19 )     6,083       6,923       (12 )
After-tax return on revenue
    10.9 %     13.1       (2.2 )pts     10.2 %     11.6       (1.4) pts
HR Outsourcing
    HR Outsourcing revenue declined in Second Quarter and Six Months 2008 compared to Second Quarter and Six Months 2007, primarily as a result of a reduction in worksite employees. As of June 30, 2008, our worksite employees were down 9% to 24,660, compared to 27,215 as of June 30, 2007, due to the current economic downturn.
 
    Pre-tax profit decreased in our HR Outsourcing business in Second Quarter and Six Months 2008 compared to the same periods in the prior year are mainly due to pricing pressure on our workers compensation product and reduced worksite lives. Workers compensation rates have been reduced by Florida regulators by 18.4% for 2008, after a 15.7% rate decrease that was effective January 1, 2007 for voluntary industrial classes. In the fourth quarter of 2007, we reduced our internal workforce at this operation by 11% to better align expenses with production.
Flood Insurance
    Our Flood revenues are primarily derived from two activities: (i) fees associated with servicing policy premium; and (ii) fees associated with handling claims. Revenue increases of 3% in Second Quarter 2008 and 8% in Six Months 2008 compared to the same periods last year were mainly attributable to the increase in servicing in-force flood premium, which increased 17% to $153.9 million as of June 30, 2008 compared to June 30, 2007. Partially offsetting this increase are: (i) a 0.5-point reduction, to 29.7%, in fees paid to us by the National Flood Insurance Program (“NFIP”) in relation to servicing premium, which was effective June 1, 2008; and (ii) a reduction in claims handling fees paid to us by the NFIP, effective June 1, 2008. The current structure includes fees of 1% of direct premiums written, which are paid even in non-catastrophe years, coupled with 1.5% of incurred losses. Prior to June 1, 2008, we received claims handling fees equal to 3.3% of incurred losses. Revenues associated with handling flood claims decreased to $0.9 million in Second Quarter 2008 compared to $1.4 million in Second Quarter 2007 and $1.0 million in Six Months 2008 compared to $1.4 million in Six Months 2007.
 
    The decrease in pre-tax profit in Second Quarter and Six Months 2008 compared to Second Quarter and Six Months 2007 is primarily due to: (i) the decrease in revenues associated with handling flood claims as mentioned above; and (ii) increased commissions to agents.
Diversified Insurance Services Outlook
Consistent with trends in the professional employer industry that are pointing to flat to negative worksite lives growth associated with the current economic downturn, we expect client sales for our HR Outsourcing products to continue to be difficult.

 

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The viability of the NFIP’s reinsurance program under the “Write-Your-Own” (“WYO”) Program is an essential component of our Diversified Insurance Services operations. The current WYO program is set to expire on September 30, 2008, but there are several bills pending in the U.S. Congress under which the program may be revised. These bills contain substantial proposed changes to the NFIP and WYO Program, which may be favorable or unfavorable for us. It is presently unclear as to the impact this legislation, if enacted, would have on our operations.
Financial Condition, Liquidity, and Capital Resources
Capital resources and liquidity reflect our ability to generate cash flows from business operations, borrow funds at competitive rates, and raise new capital to meet operating and growth needs.
Liquidity
Liquidity is a measure of our ability to generate sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. Our cash and short-term investments position at June 30, 2008 was $234.5 million, up from $198.6 million at December 31, 2007. Earlier this year, we determined that it was prudent to increase our minimum targeted cash and short-term investment balances due to the volatility in the financial markets, even though there is an opportunity cost associated with this decision.
Sources of cash consist of dividends from our subsidiaries, the issuance of debt and equity securities, and the sale of our common stock under our employee and agent stock purchase plans. However, our ability to receive dividends from our subsidiaries is restricted. Dividends from our Insurance Subsidiaries are subject to the approval and/or review of the insurance regulators in their respective domiciliary states under insurance holding company acts, and are generally payable only from earned surplus as reported in the statutory annual statements of those subsidiaries as of the preceding December 31st. Based on the 2007 audited statutory financial statements, and in light of the Second Quarter 2008 re-domestication of Selective Insurance Company of the Southeast and Selective Insurance Company of South Carolina to Indiana, the Insurance Subsidiaries are permitted to pay to Selective Insurance Group, Inc., in 2008, ordinary dividends in the aggregate amount of approximately $140.8 million. For additional information regarding dividend restrictions, refer to Note 9, “Indebtedness” and Note 10, “Stockholders’ Equity” in Item 8. “Financial Statements and Supplementary Data” of our 2007 Annual Report.
Our Insurance Subsidiaries generate cash flows primarily from insurance float, which is created by collecting premiums and earning investment income before losses are paid. The period of the float can extend over many years. To provide liquidity while maintaining consistent investment performance, we ladder our fixed maturity investments so that some issues are always maturing and providing a source of predictable cash flow for claim payments in the ordinary course of business. The duration of the fixed maturity portfolio, including short-term investments, was 3.8 years as of June 30, 2008, while the liabilities of our Insurance Subsidiaries have a duration of 3.4 years. In addition, the Insurance Subsidiaries purchase reinsurance coverage for protection against any significantly large claims or catastrophes that may occur during the year.
Another potential source of cash flows is our syndicated line of credit agreement with Wachovia Bank, National Association, as administrative agent. Under this agreement, we have access to a $50.0 million credit facility, which can be increased to $75.0 million with the consent of all lending parties. At June 30, 2008, no balances were outstanding under this credit facility.
Selective HR Solutions (“Selective HR”), our HR Outsourcing business, generates cash flows from its operations. Dividends from Selective HR are restricted by its operating needs and a professional employer organization licensing requirement that it maintain a current ratio of at least 1:1. The current ratio, which Selective HR generally maintains just above 1:1, provides an indication of a company’s ability to meet its short-term obligations and is calculated by dividing current assets by current liabilities. Selective HR provided Selective Insurance Group, Inc. with dividends of $0.9 million in Six Months 2008 and $2.6 million in Six Months 2007.

 

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Dividends on shares of our common stock are declared and paid at the discretion of our Board of Directors based on our operating results, financial condition, capital requirements, contractual restrictions, and other relevant factors. Our ability to declare dividends is restricted by covenants contained in the notes payable we issued on May 4, 2000 (the “2000 Senior Notes”). All such covenants were met during Second Quarter 2008 and Second Quarter 2007. For further information regarding our notes payable, see Note 9, “Indebtedness,” included in Item 8. “Financial Statements and Supplementary Data” of our 2007 Annual Report. At June 30, 2008, the amount available for dividends to holders of our common stock, in accordance with the restrictions of the 2000 Senior Notes, was $318.5 million. Our ability to continue to pay dividends to our stockholders is also dependent in large part on the ability of our Insurance Subsidiaries and Selective HR to pay dividends. Restrictions on the ability of our subsidiaries, particularly the Insurance Subsidiaries, to declare and pay dividends, could materially affect our ability to pay principal and interest on indebtedness and dividends on common stock. Book value per share decreased to $19.32 as of June 30, 2008 from $19.81 as of December 31, 2007.
We have historically met our liquidity requirements through dividends from our subsidiaries and by issuing debt and equity securities. We expect to meet our liquidity requirements by these sources in the future. The Insurance Subsidiaries have historically met their liquidity requirements from insurance premiums and investment income. These items have historically provided more than sufficient funds to pay losses, operating expenses, and dividends.
Capital Resources
Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks, and facilitate continued business growth. At June 30, 2008, we had stockholders’ equity of $1,017.7 million and total debt of $273.9 million.
Our cash requirements include, but are not limited to, principal and interest payments on various notes payable and dividends to stockholders, payment of claims, payment of commitments under limited partnership agreements and capital expenditures, as well as other operating expenses, which include agents’ commissions, labor costs, premium taxes, general and administrative expenses, and income taxes. For further details regarding our cash requirements, refer to the section below entitled “Contractual Obligations and Contingent Liabilities and Commitments.”
As active capital managers, we continually monitor our cash requirements and the amount of capital resources that we maintain at the holding company and operating subsidiary levels. As part of our long-term capital strategy, we strive to maintain a 25% debt-to-capital ratio and a premiums-to-surplus ratio sufficient to maintain an “A+” (Superior) financial strength A.M. Best rating for our Insurance Subsidiaries. Based on our analysis and market conditions, we may take a variety of actions, including, but not limited to, contributing capital to our subsidiaries in our Insurance Operations and Diversified Insurance Services segments, issuing additional debt and/or equity securities, repurchasing shares of our common stock, and increasing stockholders’ dividends. In Six Months 2008, we repurchased approximately 1.8 million shares of our common stock under our authorized share repurchase program at a cost of $40.5 million. As of June 30, 2008, there were 1.7 million shares remaining under the current repurchase authorization that extends through July 26, 2009.
Ratings
We are rated by major rating agencies, which provide opinions of our financial strength, operating performance, strategic position, and ability to meet policyholder obligations. We believe that our ability to write insurance business is most influenced by our rating from A.M. Best, which was reaffirmed in Second Quarter 2008 as “A+ (Superior),” their second highest of fifteen ratings. We have been rated “A” or higher by A.M. Best for the past 75 years, with our current rating of “A+ (Superior)” being in place for the last 47 consecutive years. The financial strength reflected by our A.M. Best rating is a competitive advantage in the marketplace and influences where independent insurance agents place their business. A downgrade from A.M. Best, could: (i) affect our ability to write new business with customers and/or agents, some of whom are required (under various third party agreements) to maintain insurance with a carrier that maintains a specified A.M. Best minimum rating; (ii) be an event of default under our line of credit; or (iii) make it more expensive for us to access capital markets.

 

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Our ratings by other major rating agencies are as follows:
    S&P’s Insurance Rating Services — our “A+” financial strength rating was reaffirmed in the third quarter of 2007.
 
    Moody’s — our “A2” financial strength rating and our “positive” outlook was received in the third quarter of 2006.
 
    Fitch Ratings — our “A+” rating was reaffirmed in Second Quarter 2008.
The reaffirmation by S&P cited our strong competitive position with close ties to our agents, strong operating performance, very strong operating company capitalization, and good financial flexibility. Our S&P financial strength rating and Moody’s rating also affect our ability to access capital markets. In addition, our interest rate under our line of credit varies based upon Selective Insurance Group, Inc.’s debt ratings from S&P and Moody’s.
There can be no assurance that our ratings will continue for any given period of time or that they will not be changed. It is possible that positive or negative ratings actions by one or more of the rating agencies may occur in the future. We review our financial debt agreements for any potential rating triggers that could dictate a material change in terms if our credit ratings were to change.
Off-Balance Sheet Arrangements
At June 30, 2008 and December 31, 2007, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.
Contractual Obligations and Contingent Liabilities and Commitments
Our future cash payments associated with loss and loss expense reserves, and contractual obligations pursuant to operating leases for office space and equipment, and notes payable have not materially changed since December 31, 2007. We expect to have the capacity to repay and/or refinance these obligations as they come due.
At June 30, 2008, we have contractual obligations that expire at various dates through 2023 to invest up to an additional $144.0 million in other investments. There is no certainty that any such additional investment will be required. We have issued no material guarantees on behalf of others and have no trading activities involving non-exchange traded contracts accounted for at fair value. We have no material transactions with related parties other than those disclosed in Note 18, “Related Party Transactions” included in Item 8. “Financial Statements and Supplementary Data” of our 2007 Annual Report.
Federal Income Taxes
Total federal income tax expense decreased $4.5 million for Second Quarter 2008 to $7.4 million, and $10.3 million for Six Months 2008 to $13.5 million, compared to Second Quarter and Six Months 2007, respectively. The decrease was attributable to decreased pre-tax income from our Insurance Operations and Investments segments. Our effective tax rate differs from the federal corporate rate of 35% primarily as a result of tax-advantaged investment income. The effective tax rate for Second Quarter 2008 was 20.6%, compared with 24.9% for Second Quarter 2007 and 21.6% for Six Months 2008 compared to 24.6% for Six Months 2007. These decreases are primarily the result of reduced net investment gains, which are taxed at 35%, during Second Quarter and Six Months 2008 compared to the same periods last year.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the information about market risk set forth in our 2007 Annual Report.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are: (i) effective in recording, processing, summarizing, and reporting information on a timely basis that we are required to disclose in the reports that we file or submit under the Exchange Act; and (ii) effective in ensuring that information that we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. No changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) of the Exchange Act) occurred during Second Quarter 2008 or Six Months that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our Insurance Subsidiaries as either: (i) liability insurers defending or providing indemnity for third-party claims brought against insureds; or (ii) insurers defending first-party coverage claims brought against us. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. We expect that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.
Our Insurance Subsidiaries are also from time to time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Our Insurance Subsidiaries are also from time to time involved in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information regarding Selective Insurance Group, Inc.’s purchases of its common stock in Second Quarter 2008:
                                 
                    Total Number of     Maximum Number  
    Total Number of     Average     Shares Purchased     of Shares that May Yet  
    Shares     Price Paid     as Part of Publicly     Be Purchased Under the  
Period   Purchased1     per Share     Announced Program     Announced Program2  
April 1 – 30, 2008
    4,105       23.08             2,500,835  
May 1 – 31, 2008
    569,641       21.24       563,765       1,937,070  
June 1 – 30, 2008
    188,575       21.69       188,304       1,748,766  
 
                         
Total
    762,321       21.36       752,069          
 
                         
     
1   Second Quarter 2008 included 9,877 shares purchased from employees in connection with the vesting of restricted stock and 375 shares purchased from employees in connection with stock option exercises. These repurchases were made in connection with satisfying tax withholding obligations with respect to those employees. These shares, which were purchased at the current market value of Selective Insurance Group, Inc.’s common stock on the dates of purchase, were not purchased as part of the publicly announced program.
 
2   On July 24, 2007, the Board of Directors authorized a stock repurchase program of up to 4 million shares, which is scheduled to expire on July 26, 2009.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Selective Insurance Group, Inc.’s 2008 Annual Meeting of Stockholders was held on April 24, 2008. The results of the voting, which was conducted in person and by proxy, were included in Item 4 “Submission of Matters to a Vote of Security Holders” on Form 10-Q for the period ended March 31, 2008.
ITEM 6. EXHIBITS
(a) Exhibits:
     
Exhibit No.
* 11  
Statement Re: Computation of Per Share Earnings.
* 31.1  
Rule 13a-14(a) Certification of the Chief Executive Officer of Selective Insurance Group, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002).
* 31.2  
Rule 13a-14(a) Certification of the Chief Financial Officer of Selective Insurance Group, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002).
* 32.1  
Certification of Chief Executive Officer of Selective Insurance Group, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* 32.2  
Certification of Chief Financial Officer of Selective Insurance Group, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
     
*   Filed herewith

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
             
SELECTIVE INSURANCE GROUP, INC.
   
Registrant
   
 
           
By:
  /s/ Gregory E. Murphy       August 1, 2008
 
           
 
  Gregory E. Murphy        
    Chairman of the Board, President and Chief Executive Officer    
 
           
By:
  /s/ Dale A. Thatcher       August 1, 2008
 
           
 
  Dale A. Thatcher        
    Executive Vice President, Chief Financial Officer and Treasurer    

 

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EXHIBIT INDEX
     
Exhibit No.   Description
* 11  
Statement Re: Computation of Per Share Earnings.
* 31.1  
Rule 13a-14(a) Certification of the Chief Executive Officer of Selective Insurance Group, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002).
* 31.2  
Rule 13a-14(a) Certification of the Chief Financial Officer of Selective Insurance Group, Inc. (Section 302 of the Sarbanes-Oxley Act of 2002).
* 32.1  
Certification of Chief Executive Officer of Selective Insurance Group, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* 32.2  
Certification of Chief Financial Officer of Selective Insurance Group, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
     
*   Filed herewith

 

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